Committee for a Responsible Federal Budget

Yes, Actually, We Can (at the Very Least) Make Corporate Tax Reform Revenue Neutral

Nov 7, 2011 | Taxes

As policymakers look to "Go Smart" in putting together a deficit reduction package, there is no better place to look than tax reform; and in particular, corporate tax reform. According to the Joint Committee on Taxation (JCT), even a roughly 5 percent decrease in the corporate rate would increase the size of the economy by between 0.5 and 0.9 percent over the long-run, depending on how it was financed; not to mention what corporate tax reform can do to encourage international competitiveness and put industries and firms on a more level playing field.

Given the need for improved competitiveness, it's no wonder then that the Fiscal Commission called for corporate tax reform -- proposing a plan that reduced the rate to 28 percent, eliminated corporate tax expenditures, and moved to a competitive territorial system -- or that House Ways and Means Chairman Dave Camp (R-MI) released a discussion draft of a similar plan that would reduce the rate to 25 percent.

Given our mounting fiscal challenges, however, reforming the tax code cannot be a revenue-losing proposition. Because of this, corporate tax reform should be accompanied by additional tax reform measures to ensure that it is at the very least revenue neutral.

Recently, Ways and Means Democrats released a report aiming to show that the corporate rate cannot be reduced to 25 percent -- as Chairman Camp proposes -- without adding to the deficit. According to them, "A new Joint Committee on Taxation analysis shows that eliminating every corporate tax credit and deduction would generate only enough savings to reduce the corporate tax rate to 28 percent, well short of the 25 percent proposal Republicans have put forward."

And at first glance, the report does seem to conclude that -- though on closer examination it is clear that it does not. JCT puts international issues aside -- since Chairman Camp says those will be addressed in a way that makes his territorial system revenue neutral -- and attempts to estimate the effect of reducing most other corporate tax expenditures. Here are the basic results: 

 Tax Expenditures RepealedTotal SavingsSavings from C Corporations
Expensing for R & E$160 Billion$150 Billion
Various Energy and Natural Resources$36 Billion$14 Billion
Low Income Housing Credit$35 Billion$33 Billion
Rehabilitation Credit$6 Billion$4 Billion
Deferral of Gain on Like-Kind Exchanges$18 Billion$16 Billion
Completed Contact Rules Method$14 Billion$14 Billion
Credit for Employer-Paid FICA Taxes on Tips$8 Billion$5 Billion
Domestic Production Activities$164 Billion$127 Billion
LIFO and Lower Cost of Market$73 Billion$66 Billion
Pro-rate Interest Expense Disallowance for Company-owned Life Insurance$7 Billion$7 Billion
Blue Cross/Blue Shield Deduction$5 Billion$5 Billion
ESOP Dividends$6 Billion$6 Billion
Exclusion for Private Activity Bonds$9 Billion$9 Billion
Accelerated Depreciation & Recovery$724 Billion$507 Billion
Subtotal of Base Broadening$1,265 Billion$964 Billion
Reduce Rates to 28 Percent-$718 Billion-$718 Billion
Interaction-$243 Billion-$243 Billion
Subtotal of Estimated Changes$304 Billion$4 Billion
Roughly Estimated Neutral Rate25%-26%28%

Indeed, as it turns out, the reduction to 28 percent assumes that only revenue gained from C-Corps, not from pass-throughs such as S-Corps, would be used to lower rates. JCT finds that in reality, the combination of base broadening and reducing the rate to 28 percent would produce about $300 billion in revenue, enough to reduce the rate to between 25 and 26 percent. To be sure, there is a legitimate concern over fairness if policymakers choose to subsidy C-Corp rate reduction through revenue from S-Corps; and policymakers may choose not to take this route. Such concerns could also be mitigated by combining individual tax reform with corporate reform.

On top of that, it's important to note that JCT was not able to estimate the elimination of a large number of tax expenditures, including those for deferral of gain on on-dealer installment sales, special treatment of life insurance company reserves, and the exemption of credit union income. Those are currently listed as "presently unavailable," and not counted in the score. As George Callas over at the Ways & Means Committee has noted, there are 90 tax expenditures in the JCT table where they say this. Though we don't claim to be able to estimate what JCT has not estimated, it is telling that the value of these tax expenditures (on a static basis) adds up to about one quarter of the total non-depreciation tax expenditures. In rough terms, that means they could be worth $150 to $200 billion -- enough to possibly reduce the rate to 24 percent.

And then, of course, there are other options not related to tax expenditures. For example, the Wyden-Coats legislation made interest above inflation taxable to raise over $150 billion. Add that into the mix, and you could reduce the rate to about 23 percent.

* * * * *

Our basic point is that lawmakers can, indeed, reduce the corporate rate in a fiscally responsible manner -- though policymakers should be careful to pay attention to the long-term effects rather than just the 10-year score, particularly since many tax preferences are the combination of somewhat modest subsidies and quite substantial timing shifts (for example, accelerated depreciation). Given that, any reform must not only be at least revenue neutral over ten years, but also in the tenth year and beyond. To the extent that this allows for extra revenue in the interim years, they should be used for deficit reduction (as well as to finance any costs of transitioning to a new tax system).

Reforming the corporate tax code won't be easy -- reaching a target like 25 percent will require essentially wiping out all the tax expenditures on the corporate side of the code. But as lawmakers do everything thing they can to also give the economy its best chance at robust growth, we must also focus on deficit reduction. That means reforming the individual and corporate tax code, in addition to entitlement reforms, and making hard choices so the net effect of reform is to substantially reduce the deficit, even while lowering rates.